[Intl-tobacco] Tobacco Reporter: BAT prospects; privatization helps

[Robert Weissman]

snip: With the eagerly anticipated privatization of state-held monopolies
in South Korea, Taiwan, Thailand, Italy, Turkey and Egypt, BAT will have
plenty of opportunities to expand. snip

THE POWER OF REGIONALISM - Tobacco Reporter

Capitalizing on its strength in local markets, British American Tobacco
has crafted a formidable global entity.

June 2001

By Brandy Fisher

Coming off one of the most successful mergers in recent history, British
American Tobacco is well-established as the No. 2 global cigarette giant,
with more than 16 percent of the world market. BAT=92s success can largely
be attributed to its positioning in key promising markets. As if to prove
this point, on May 2, BAT announced it was in talks with the Chinese
government about the possible establishment of a new joint venture in
Sichuan Province, an important part of the world=92s largest cigarette
market.

EMERGING MARKETS. =93BAT=92s strengths are its positioning in Asia and over=
all
position in the emerging markets, because these are the markets where
we=92re still seeing growth,=94 says Pieter Vorster, analyst for Credit Sui=
sse
First Boston.

In these markets, BAT has a knack for maintaining a local flavor to its
acquired operations. =93BAT=92s prime strength is its local and regional fe=
el
of a lot of its business,=94 says Jonathan Fell, an analyst for Merrill
Lynch. =93It has very strong local and regional brands, appearing to be a
local company more than Philip Morris, which seems to address all markets
in the same way.=94

Michael Smith, an analyst for Morgan Stanley, points out BAT=92s strongest
positions in key emerging markets=9770 percent of the Indian market; more
than 50 percent of the market in Latin America; and a 69 percent share in
Malaysia.

=93BAT has a disproportionately high market share in the markets which are
growing. Whereas Philip Morris is more weighted to North America and
western Europe, BAT is more weighted to emerging markets,=94 says Smith.

However, BAT doesn=92t have a coveted international brand. =93Its major
weakness is that it doesn=92t have a Marlboro,=94 says Fell. =93But no one =
does;
Marlboro is the only global brand as far as I=92m concerned. Marlboro beats
everyone by miles and miles.=94

Vorster says there is a positive side to BAT=92s lack of a global brand.
=93Nobody has a Marlboro, but you can see it as a strength because they are
not dependent on one brand.=94

However, international brands are more profitable than local brands. Local
brands are important, but, Smith says, =93Over time, the international
brands are growing faster. We estimate that international brands earn
three times more profit per pack than local brands. Clearly, it=92s to the
manufacturers=92 advantage to get smokers to trade up.=94

He adds, =93It=92s a clear weakness that they [BAT] don=92t have a brand wh=
ich
has the scale of Marlboro.=94 He points out that Lucky Strike sells at a
rate of 25 billion sticks per year, while Marlboro sells nearly 500
billion sticks per year. =93BAT lacks the size and scale of a leading brand
that allows global marketing.=94

He says BAT is trying to change this, and the company might have some
success. =93It could grow more of an international brand. No doubt the key
is to grow Lucky Strike, but it will never be a Marlboro. With the limits
on advertising and promotions today, there will never be another
Marlboro.=94

U.S. MARKET. One market where BAT can=92t seem to get a strong position is
the United States. Its subsidiary, Brown & Williamson, recently relaunched
Pall Mall in the United States, which may help turn things around a
little.

=93In the U.S, BAT is still losing market share, although at a slower rate
than previously. It is important that its position improves here,=94 says
Vorster.

Smith says BAT lacks products in the United States with brand equity,
which is the current value of all future cash flow from the brand. =93The
U.S. is by far the most important market in the world. BAT has not been
successful there because of a lack of brand equity. Pall Mall could
possibly have some impact. In the past, they=92ve relied too much on GPC.
Pall Mall has more brand equity.=94

=93It=92s reasonable to move away from price=97to include heritage,=94 says=
 Fell.
=93It=92s far too early to tell. It=92s very difficult to make progress in =
the
U.S. against PM because it is so powerful.=94

MERGER. The rollout of the Rothmans merger in early 1999 has drawn rave
reviews from analysts. BAT had originally forecast cost savings of =A3250
million by 2002, and the company has already realized =A3230 million.
Analysts anticipate that the final figure could be close to =A3350 million.

=93The merger has gone exception ally well and it must be one of the most
successful mergers in recent corporate history,=94 says Vorster.

Fell concurs, =93It appears to be very much on track. It must be one of the
more successful of the larger mergers. The savings are quite a lot bigger
than initially expected, which is partly deliberate; they wanted to pick a
figure they could meet, but it has been quite impressive so far.=94

BUY. Analysts have been highly recommending BAT as a buy. Its stock price
has long been discounted due to BAT=92s exposure to litigation in the Unite=
d
States. However, the risks of litigation are abating and analysts expect
the price to rebound.

=93Because of the exposure to litigation in the U.S., BAT is still trading
at a substantial discount, and as the litigation climate improves, the
discount will continue to decline,=94 says Vorster.

Smith concurs, =93BAT has the lowest valuation in Europe. With the improvin=
g
litigation climate, Philip Morris and RJR have already improved. We expect
to see some catch-up by BAT as well.=94

CHINA. BAT=92s anticipated new joint venture in China bodes well, too. BAT
is in an excellent position to succeed in China, if and when the market
opens up. Before China=92s cigarette industry was nationalized in 1939,
BAT=92s brands dominated nearly half of the Chinese market. Its brand State
Express 555 is one of the most well-recognized international brands in
China, selling better than Marlboro, even at a higher price.

=93That historic brand equity has remained in place,=94 says Smith, even
though BAT brands in China are mostly counterfeit. Very few genuine BAT
brands are sold in China due to excise taxes of 240 percent on imported
international cigarettes, as well as limits on retail sales of imported
cigarettes.

=93BAT has tremendous brand recognition in China. They have a lot of brand
equity in China with State Express 555 and Hilton,=94 says Fell. =93If BAT =
is
ever allowed to sell in China, it could be quite a success. They have been
lobbying for years, and lately I=92ve detected hints that they=92re getting
more optimistic.=94

Vorster adds, =93The brands acquired from Rothmans, such as Dunhill, are
very strong in Asia.=94

However, speculation is still premature, as no one can predict if and when
the Chinese market will open up. =93I wouldn=92t say in the near future=97i=
t
depends on the WTO and American-Chinese relations, which aren=92t very good
right now. It=92s difficult to say when,=94 says Vorster. =93It is the priz=
e
market, and I think many will succeed there=97not just one or two.=94

Smith says, =93I know they are optimistic that talks with the WTO will lead
to some breakthrough. It=92s difficult to know the time frame=97it could be
three years; it could be 10 years.=94

FUTURE ACQUISITIONS? BAT has demonstrated its hunger for growth and its
willingness to take risks. =93They have financial flexibility; they=92ve go=
t a
high level of interest coverage to take a significant amount of debt to
make acquisitions,=94 says Smith. He expects BAT to remain active and
focused on emerging markets.

With the eagerly anticipated privatization of state-held monopolies in
South Korea, Taiwan, Thailand, Italy, Turkey and Egypt, BAT will have
plenty of opportunities to expand. TR